Withdrawal of the 20% tax proposal levied on foreign owners of second homes

The good news is that the government's proposal of a yearly 20% tax on second homes has been removed from the final draft of the Bill. It would have been assessed on the rental cadastral value of the property (i.e. same basis as the local tax called Taxe Fonciere) and levied on foreign owners. The exemption for those owners renting out the property would have been almost impossible to achieve due to the high proportion the French letting income should have represented in the total worldwide income of that investor. It was also likely to be challenged under European Law as it did not apply to French-based owners thus creating discrimination.

Change in the French CGT applicable to second homes

Owners of second home or investment properties have until now been enjoying a generous exemption: they were fully exempted from capital gains tax in France after 15 years of ownership due to an allowance of 10% off the gain for every year of ownership above the 5th one. This allowance has now been withdrawn. However as compensation, inflation can be offset from the gain. Owners exchanging contract from 24 August 2011 will be affected. Only a main home remains exempted. All other properties follow the new regime.

Wealth Tax Amendments

Every year, a household may be liable to pay a wealth tax if the net value of their assets is above a certain threshold which has now been increased from € 800,000 to € 1,300,000. Non-French residents are liable on the net value of their French based assets but excluding their French financial investments. British nationals relocating to France enjoy the same regime as non-residents for the first 5 years only. After 5 years however, like any French residents, the value of their worldwide assets is taken into account.

The second modification is a simplification in the rates. The progressive rate from 0.55% to 1.8% has been replaced with a fixed 0.25% from the first Euro for assets of up to 3 million Euros, and 0.5% from the first Euro for assets above 3 million Euros.

Taper relief is in place for those having an estate worth between 1.3 and 1.4 million Euros and between 3 and 3.2 million Euros.

The deadline for filing the 2011 wealth tax return has been postponed to 30/09/2011.

Loophole closed for shareholders of SCI (real estate companies)

Non-residents buying their French property via an SCI were able to decrease the net value of their shares for wealth tax purpose by lending the purchase price to their SCI. This debt was recorded in the SCI's account under a shareholder's account. This solution worked only for non-French residents because they are exempt from wealth tax on their French financial investments.

It allowed a cash buyer to create a debt on the value of their shares. It will not be possible now and only a commercial loan will be deductible from the gross value of the shares. Shareholders, either directly or indirectly, will not be able to finance the purchase by their SCI for wealth tax planning.

Increase in the French inheritance tax rates

The last two tax bands of French inheritance tax have been raised from 35% to 40% and from 40% to 45%. This affects the portion of an estate above € 900,000.

New taxation regime for foreign Trusts

For the first time, the legislator creates a tax regime applicable to foreign Trusts. Until then, case law tried to match foreign legal concepts to their closest equivalent in French law and apply the corresponding tax regimes, with the uncertainty and inaccuracy that inevitably led to.

Firstly, a fiscal definition of the Trust is created in Section 792-0 of the tax code as follows: "a trust is the set of legal relationships created under a foreign law by a settlor, by an act inter vivos or on death, in order to transfer assets or rights under the control of an administrator [trustee] in the interest of one or more beneficiaries or for the fulfilment of a particular purpose."

Secondly, trusts that will be affected are those where the settlor/donor is domiciled in France, in which case the basis of taxation will be the Trust worldwide assets; or where the settlor/donor is not French domiciled but the Trust contains French based assets (Section 750 ter of the French tax code).

Tax on income

(Section 120, 9 of the French tax code)

The reform confirms that income distributed to a French beneficiary is subject to income tax or corporation tax, as opposed to income re-invested in the Trust which is not.

Wealth tax

(Section 885 G Ter of the French tax code)

Regarding the wealth tax, the settlor, or if he has passed away the beneficiaries, are liable to this tax at the highest rate of 0.5% a year if his assets total more than €1,300,000. The rate of 0.25% available to individuals having less than 3 million Euros worth of assets is not available here.

Note that the new law does not make any distinction between discretionary and non-discretionary trusts, as was the case with case law. Discretionary trusts used to be exempted from wealth tax on the trust assets until there was an actual distribution to a beneficiary because it could not be said under French law that the asset belonged to either the settlor or the beneficiary.

The onus is on the trustees to declare the value of the taxable assets and lodge the tax form, failing which the settlor and beneficiaries or their heirs will be jointly and severally liable.

Disclosure obligations by the trustees

(Section 1649 AB of the French tax code)

The trustees will have an obligation to disclose a wide range of information to the French Revenue: the Trust's constitution, modification, extinction, its provisions and the value on the 1st January of each year of those Trust assets taxable in France (worldwide assets if the settlor is French domiciled, or French based assets only otherwise).

Failure to declare this information will be punished by a fine of € 10,000 or 5% of the value of the Trusts assets and income, whichever is greater, borne jointly and severally by the settlor, beneficiaries and the trustee.

Withholding tax

(Section 990J of the French tax code)

From 1 January 2012, a sui generis tax of 0.5% would apply to the Trusts assets.

However, this tax is not owed for those who have lodged their wealth tax return and paid the appropriate tax, or those who have complied with the disclosure information above and are underneath the wealth tax threshold of currently 1.3 million Euros. Also, discretionary Charity trusts and Pension trusts are exempted.

Inheritance and Gift tax

The provisions which will impact the most on foreign trusts will no doubt be the ones creating a specific regime of French inheritance tax (which is applicable both on death and on lifetime gifts) which aims to tax the Trust's assets at every stage of the Trust life, i.e. when the settlor dies, and when the successive beneficiaries die. The latter are deemed to become the settlor for the purpose of this tax.

Three rules are created:

• if at the time of the settlor's death, the exact share which a beneficiary is entitled to is known, that share will be subject to the rates applicable between the settlor and that beneficiary which in France depends on their family relationship (e.g. rates between parent and child). Here the regime follows that which applies when there is no trust and assets are inherited straight from a parent.
• if at the time of death, the share is globally attributed to the descendants of the settlor, the highest rate between parent and children will apply, i.e. 45% (and not the more generous tax bands as above).
• in all other cases, the assets or the portion not going to any of the previous 2 categories, will be taxed at 60%.

To conclude, one can regret that the French regime negates the foreign laws and does not take into account their specific characteristics such as discretionary or irrevocable trusts. It is clearly a repressive regime aimed to fight tax evasion. Further decrees are expected before January 2012.

© Marie Slavov - Blake Lapthorn

September 2011

Marie Slavov is an Avocat with Blake Lapthorn

Email: marie.slavov@bllaw.co.uk

Tel:023 9253 0346